Standing Repo Facility Watch – Is the Fed’s ceiling tool working?

Repo storm hit again as rate surge at November-end

Key Implications: This is the second month-end in a row the Fed saw repo rate surge past its federal funds rate target range. December 1 is also the day the Fed ended its quantitative tightening program, which should help ease liquidity strain in the market in general.

What is the Standing Repo Facility?

The Standing Repo Facility (SRF) is the Federal Reserve’s permanent “ceiling tool.” Established in July 2021, it allows Primary Dealers and eligible banks to borrow cash overnight from the Fed by offering safe assets such as US Treasuries and agency mortgage backed securities as collateral.

The Specs

• The Rate: Priced at the top of the Fed Funds target range, acting as an interest rate ceiling tool.
• The Limit: Capped at $500 billion per day.
• The Goal: To prevent a repeat of the 2019 Repo Crisis by ensuring cash is always available during stress events.

Why the SRF isn’t Fixing the “Leaky Ceiling”

The fact that Standing Repo Facility once again failed to put a cap on the money market interest rates showed that the so-called “leaky ceiling” problem continues to haunt the Fed.

Should the Fed be more concerned that its interest rate ceiling tool failed to put a lid on the repo rates?

Looking through the period-end surges

Period-end surges in repo rates are generally regarded as “tolerable” by the Fed. This is because the main culprit during such periods is well known.

Dealers usually find their balance sheet capacity limited by regulatory factors, so they reduce their participation in the repo transactions, generating volatility in the repo rates.

As these period-end fluctuations more often than not reflect regulatory limitations instead of a genuine market-wide liquidity shortfall, the Fed has some leeway to look through these effects.

Repo rates are not the Fed’s official target

As Roberto Perli, manager of the New York Fed’s System Open Market Account, said in a mid-Nov speech, repo rate surges are “not concerning” because the target range is defined in terms of the federal funds rate (FFR). As long as the effective FFR is below the US central bank’s upper limit, the Fed should not panic.

It’s only when the repo rates stay “persistently or substantially above the top of the target range” that the situation would become problematic, as “they could pull up the EFFR and pose difficulties for rate control,” Perli explained.

It’s a liquidity backstop and it carries stigma

SRF is designed as a liquidity backstop, instead of a liquidity provision tool. As New York Fed President John Williams emphasized, banks should not rely on the this facility as a source of liquidity day-to-day. Hence, the SRF is supposed to be quiet on “normal” days; but its usage should shoot up when there are temporary liquidity strains in the system, much like the usage pattern during November.

This usage pattern, nonetheless, can breed a stigma problem, where financial institutions would become wary of sourcing liquidity from the Fed tool as ‘unusual’ usage would be considered as a sign of weakness. Banks tend to avoid any association with such signals at all costs as loss of confidence can destroy a bank in an instant.

Even though only overall SRF usage—instead of the amount an individual financial firm lends—is disclosed daily, primary dealers in a mid-November behind-the-door meeting told the New York Fed that they are reluctant to use SRF because they consider “borrowing directly from the central bank still carries a stigma and could be seen as a sign of trouble,” as Bloomberg reported.

What Next?

The Fed is planning on easing the month-end repo rate surge by introducing central clearing in SRF transactions. Central clearing can help free up dealers’ balance sheet capacity to lend from the SRF.

As explained in the October meeting minutes, “[c]entral clearing could increase counterparties’ willingness to use the SRF when there is upward pressure on repo rates, which would damp pressures on the federal funds rate.”

📚 Deep Dive on the SRF

Track the evolution of the Fed’s ceiling tools through our archived analysis:

• • Why rates are breaking the cap: The Fed’s ‘Leaky Ceiling’ Problem
  • The philosophical difference from the Bank of England’s demand-driven system: Backstop vs. Provision
  • Why Ending QT Too Soon Risks Discrediting the SRF
  • Why SRF should be the most important Fed tool post QT: The Fed’s Post-QT Tool?